What Drives the Return on CMBS?
Journal of Portfolio Management, 33(5), 145- 157, September 2007
Xiaoqing Eleanor Xu, Ph.D., CFA Department of Finance
This paper sheds light on the investment performance of Commercial Mortgage-backed Securities (CMBS) as an asset class, the driving forces behind CMBS return variability, and the relative importance of these variables in predicting CMBS returns. Using monthly data on Lehman Brothers fixed income indices from January 1997 to June 2006, I find that the total risk-adjusted returns on investment-grade and high-yield CMBS clearly dominate those on investment-grade and high-yield corporate bonds, Treasuries, and stocks. I use a structural vector autoregressive model to determine the variables that drive the excess returns on CMBS and how each variable does so. Impulse response analysis indicates that growth in industrial production, change in mortgage rate, change in term structure spread, and excess return on S&P 500 all have significant and negative contemporaneous effects on the excess returns on investment-grade and high-yield CMBS. Variance decomposition reveals that the change in mortgage rate and the term structure spread together explain 57% and 45% of the variance in investment-grade and high-yield CMBS excess returns, respectively. Change in the amount of CMBS issuance shows a significant negative lag effect on CMBS excess returns. The required returns on CMBS are positively driven by the changes in credit spread and negatively driven by the changes in the credit worthiness of the securitized commercial mortgages, but these effects are much stronger for high-yield CMBS than for investment-grade CMBS.